A
funny thing has happened since investors pulled more than $100 billion from
bond mutual funds this summer as they worried that the 30-year run for bonds
was coming to an end. Bond funds are no longer losing money, at least not
recently. Almost every kind has made money over the last month.

To
be sure, the gains are over only a short period and are modest, but money
managers say conditions are in place for bond funds to offer flat to modestly
positive returns over the next year or so, a better outcome than many investors
feared.

"Just
because the bull market for bonds has ended doesn't mean that the bear market
has to begin," says Jim Kochan, chief fixed-income strategist for Wells
Fargo Funds Management. "The ingredients that typically are necessary for
an upward trend in bond yields -- for a true bear market -- are simply not in
evidence."

Interest
rates are key because they dictate prices for bonds. When rates fall, they make
the higher yields being paid by existing bonds more attractive to investors.
The increased demand means their prices rise. When interest rates rise, the
opposite occurs. The effect is more pronounced for bonds that have a longer
time until maturity. If bond prices fall enough, they overwhelm the income
payments that bond funds make and leave investors with losses.

Rates
rose throughout the summer on speculation that the Federal Reserve was
preparing to pull back on its economic stimulus, which includes $85 billion in
monthly bond purchases to keep interest rates low. The yield on the 10-year
Treasury note rose from 1.63 percent at the start of May to nearly 3 percent by
early September.

But
the central bank surprised investors in mid-September when it said that it
wanted to see more evidence of improvement in the economy, and it decided to
maintain its bond purchases. The Fed said much the same thing at its latest
policy meeting, which ended on Wednesday. The yield on the 10-year Treasury has
since dropped to about 2.6 percent.

The
moderation in interest rates helped intermediate-term bond mutual funds -- the
most popular bond fund category with about $977 billion in total assets -- to
rise 1 percent over the last month. It's a turnaround from the summer, when the
average fund fell 1.6 percent in May, 2.1 percent in June and 0.7 percent in
August. July had an average gain of 0.3 percent for the category, according to
Morningstar.

"It
can be a little scary now, the environment for fixed income," says David
Hillmeyer, a senior portfolio manager who helps run Delaware Diversified Income
(DPDFX) and other bond funds for Delaware Investments. "But realize that
there are some important components that are supportive of bonds and that it's
not all just negative."

Weak
economic growth is serving as a brake on interest rates, helping to hold them
down and support bond prices, Hillmeyer says. The U.S. economy will likely grow
1.6 percent this year, according to the International Monetary Fund. That's
down from an earlier estimate of 1.7 percent, and would mark a slowdown from
last year's growth of 2.8 percent. By comparison, growth was as strong as 3.8
percent in 2004, during the middle of the last economic expansion from 2001
through 2007.

Another
factor that could send interest rates higher, inflation, has also been tame.
The Consumer Price Index rose 1.2 percent in September from a year earlier.
That's down from the 2 percent inflation rate in September of last year and 3.9
percent two years ago. Economists expect inflation to stay under control,
partly because the sluggish job market means wages aren't rising for many
households.

"We
actually think the environment is quite attractive for bonds right now,"
says Richard Lawrence, senior vice president of portfolio management at
Brandywine Global, which manages $48 billion in assets. His firm bought
Treasurys during the summer and also bought bonds from Mexico, Brazil and other
countries that are more sensitive to moves in interest rates.

Lawrence
suggests looking to mutual funds that own foreign bonds, which can offer a
greater diversity of investments. Foreign bond funds behaved much like U.S.
bonds did during the summer when everything fell together. But they have since
returned to moving independently of each other, with some zigging while others
zag.

Bonds
from other countries can also offer higher yields, though they carry an
additional risk for investors. If they are denominated in a foreign currency,
U.S. investors can suffer losses if the dollar's value swings in the wrong
direction.

Although
bond funds may not be suffering the double-digit losses that some feared in a
bear market, they won't offer the same big returns that they used to. Yields
are low, which means they offer less income, and they have less cushion to
absorb a rise in interest rates.

Intermediate-term
bond funds are down an average of 0.7 percent so far this year, after enjoying
annual returns of 5.9 percent to 14 percent over the last four years. The
recent performance of bonds also pales in comparison to stocks, which have
surged since hitting a bottom in 2009. Large-cap growth stock funds have
returned 26.3 percent this year.

That
dominance for stocks means Kochan, the Wells Fargo fixed-income strategist,
says he can no longer joke that stocks are "the inferior asset
class."

"But
investors are not being well served by some of the more dire forecasts about
how bonds will perform," he says.